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Non-Traded REITS: A Fool and His Money

As the Fed continues sucking yield out of the marketplace, individual investors are desperate for return.  This has fueled a moon-shot in a host of dicey instruments sold only on the basis of percentage returns. 

 

Hedgeye energy analyst Kevin Kaiser has written extensively on oil and gas Master Limited Partnerships, many of which are purely accounting exercises designed to lure investor money to pay management compensation.

Non-Traded REITS: A Fool and His Money - Atlas cartoon

Oil and gas aren’t the only sure thing in America today.  There’s also real estate, available in “non-traded REITS.”  These are illiquid private investments.  Since the function of the marketplace is price discovery, where real transactions establish a real-time market price, how does your brokerage firm price non-traded instruments on your statement?

 

Simple.  All non-traded REITs are priced $10 a unit, regardless of the value of the underlying portfolio.  Non-traded REITs are sold to the investor at $10 a share, and FINRA permits them to remain on brokerage statements at original sale price.   Since REITs are very long-term instruments, it will be a long time before the investors find out the actual value of their holdings – typically, only when the REIT goes bust because there is no residual value to the properties.

 

Non-traded REITS are marketed as being “stable” – because they’re not subject to market price fluctuations – and have become increasingly popular as investors grow desperate in a world without yield.

 

Even if they’re not so great for you, they are a great deal for the firms that sell them.

 

A typical non-traded REIT can pay a 7% sales commission, plus a 2.5% “dealer management fee” and 3% in offering expenses – all taken off the top.  You end up with 87.5 cents of every dollar actually invested: your REIT has to appreciate 14% in value before you are even.

 

The REIT managers also pay themselves ongoing fees.  One real-world example had managers taking a 4.5% annual management fee, plus 3% for leasing properties.

 

But wait – there’s more.  Because they are often blind pools, the REIT managers don’t buy real estate until all the money is in (there appears to be no rule barring managers from selling their own operating properties to the REIT they manage, a massive self-dealing loophole.)

 

During the process of acquiring the properties for the REIT, they make regular payments to the investors.  These payments are non-taxable (great!) because, since there are no operating properties in the portfolio, they’re just giving you back your own cash (oh… not so great).  And recording it as yield (how’s that?!)

 

In 2011 industry oversight body FINRA proposed a rule requiring disclosure of the actual value of these investments.  This month, over 2 ½ years later, FINRA says they aren’t ready to send the rule proposal to the SEC.  They are still mulling over the comments they received.

 

The comments appear to be overwhelmingly objections from the firms who market these instruments.  As with many other public comment exercises, if you want to know what the average retail investor thinks of non-traded REITS, don’t ask FINRA.  They don’t know.

 

As sales of these instruments swelled to $20 billion in 2013, the best FINRA could do was to issue Investor Guidance (Public Non-Traded REITs—Perform a Careful Review Before Investing)

 

The fecklessness of FINRA and its efforts at investor protection goes a long way towards explaining the explosion in these types of investments.  “You gonna listen to the regulators?!” says the salesman.  “They don’t know the first thing about the markets!”  While we generally can’t argue with that proposition, it does not logically follow that one is better off embracing the advice of a salesman who won’t tell you how much he’s getting paid on the transaction (if you ask, he is required by law to give you a full description of commissions, fees and charges.)

 

The Fed’s prolonged QE program is intended to boost asset prices, raising the price of securities by creating dollar inflation and praying that wealth will magically “trickle down” throughout the economy, a fairy tale Washington and Wall Street have been telling us for two generations. 

 

The Fed hasn’t learned two basic lessons of finance: the money business brings out the worst in people; and what goes around, comes around.  You can’t inflate forever.

 

Legendary former Bear Stearns head Ace Greenberg warned in the early stages of the 1980’s bull market that growth in the financial sector would attract criminals and scam artists in their legions.  While Ace was slugging it out in the trenches, Bernanke and Yellen were assiduously taking notes in their advanced Econ seminars. 

 

If you want to know why the store is in such rotten shape, you need only look at who’s minding it.


Continue to Tread Carefully in Consumer Staples | $XLP

Takeaway: The sector is loaded with a premium valuation (P/E of 19.6x).

Continue to Tread Carefully in Consumer Staples | $XLP - brazil

 

Consumer Staples was flat week-over-week versus the broader market (SPX) up 1.2%. XLP is up 3.0% year-to-date versus the SPX at 2.8%. 

 

Our Consumer Staples team continues to believe that the group is facing numerous headwinds, including:

  • U.S. consumption growth is slowing as inflation rises, in-line with the Macro team’s 1Q14 theme of #InflationAccelerating, and Q2 2014 theme of #ConsumerSlowing.
  • The economies and currencies of the emerging market – once the sector’s greatest growth engine – remain weak with the prospect of higher inflation in 2014 eroding real growth.
  • The sector is loaded with a premium valuation (P/E of 19.6x).
  • Less sector Yield Chasing as Fed continues its tapering program.
  • The high frequency Bloomberg weekly U.S. Consumer Comfort Index (recently rescaled for cosmetic and not component reasons) has not seen any real improvement over the past 6 months, and fell to 34.1 versus 34.9 in the prior week.

Continue to Tread Carefully in Consumer Staples | $XLP - 4

 

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Editor's Note: This is an excerpt of a research note that was originally provided to subscribers on May 27, 2014 by Hedgeye Consumer Staples analyst Matt Hedrick. Follow Hedgeye's Consumer Staples sector @HedgeyeStaples.

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Protein Focus! M&A Activity Heating Up in the Food Business

The Hedgeye Restaurants team posted a note earlier today on the impact of M&A deals between Hillshire Brands' (HSH), Pilgrim's Pride (PPC), and Pinnacle Foods (PF), which we've included below as it relates to the food industry.

 

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BOBE: M&A Activity Heating Up in the Food Business

 

Following Hillshire Brands’ (HSH) recent agreement to acquire Pinnacle Foods (PF) for about $4.3 billion, Pilgrim’s Pride (PPC) announced its proposal this morning to acquire HSH for $45.00 in cash.  The transaction, which is valued at $6.4 billion, places a 25% premium on the volume weighted average price of HSH shares over the 10 trading days following the announcement of the PF transaction.  In the deal, PPC would pay 12.5x TTM EBITDA for HSH.  According to the release, the proposal has the “unanimous support” of both Pilgrim’s and JBS SA’s Board of Directors.  PPC will finance the acquisition with a mix of existing cash and new debt financing.

 

Merging with HSH will allow PPC to expand its business in branded foods, an area that only makes up 20% of PPC’s current sales.  According to the release, the goal of the transaction is to create “a leading branded, protein-focused company with strong, consistent earnings and complementary competencies.”  HSH’s current brand portfolio consists of leading brands in core categories, including Jimmy Dean, Hillshire Farm, Ball Park, State Fair, Aidells and others.

 

This deal was of particular interest to us because it highlights the surging demand for packaged and prepared foods companies.  This ties directly into our Long BOBE Best Idea thesis, which calls for the spinoff or sale of BEF Foods that activist Sandell Asset Management first suggested.

 

In the case of BOBE, we see tremendous upside value in separating the foods business from the restaurant business and believe the company could spinoff BEF Foods at a substantial premium to its current value.

 

The food processing business is linked to the founding of the company and, to be clear, we fully appreciate the desire to maintain tradition within a business.  With that being said, we believe this connection is severely limiting the potential of the company.  Other than the historic connection between BEF Foods and Bob Evans Restaurants, there are very few, if any, synergies between the businesses.  We believe each business would benefit greatly from laser-focused, uncompromised operating strategies.  A separation would allow BOBE to focus on efficiently running its restaurants, while enabling BEF Foods to increase sales in the foodservice industry and further diversify its customer base.  As a separate entity, we believe BEF Foods would have an enormous runway for growth.

 

We maintain that such a transaction, in conjunction with significant SG&A cuts at BOBE, would result in substantial shareholder value creation for shareholders.

 

Protein Focus! M&A Activity Heating Up in the Food Business - bobe

 

Howard Penney

Managing Director

 

Matt Hedrick

Associate

 

Fred Masotta

Analyst


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Video | McCullough Answers Questions on Monetary Policy, Fiscal Policy, the Dollar, Earnings and More

Here’s the question-and-answer portion from our daily institutional Morning Call hosted by Hedgeye CEO Keith McCullough and macro analyst Christian Drake.

 


BOBE: M&A Activity Heating Up in the Food Business

Following Hillshire Brands’ (HSH) recent agreement to acquire Pinnacle Foods (PF) for about $4.3 billion, Pilgrim’s Pride (PPC) announced its proposal this morning to acquire HSH for $45.00 in cash.  The transaction, which is valued at $6.4 billion, places a 25% premium on the volume weighted average price of HSH shares over the 10 trading days following the announcement of the PF transaction.  In the deal, PPC would pay 12.5x TTM EBITDA for HSH.  According to the release, the proposal has the “unanimous support” of both Pilgrim’s and JBS SA’s Board of Directors.  PPC will finance the acquisition with a mix of existing cash and new debt financing.

 

Merging with HSH will allow PPC to expand its business in branded foods, an area that only makes up 20% of PPC’s current sales.  According to the release, the goal of the transaction is to create “a leading branded, protein-focused company with strong, consistent earnings and complementary competencies.”  HSH’s current brand portfolio consists of leading brands in core categories, including Jimmy Dean, Hillshire Farm, Ball Park, State Fair, Aidells and others.

 

This deal was of particular interest to us because it highlights the surging demand for packaged and prepared foods companies.  This ties directly into our Long BOBE Best Idea thesis, which calls for the spinoff or sale of BEF Foods that activist Sandell Asset Management first suggested.

 

In the case of BOBE, we see tremendous upside value in separating the foods business from the restaurant business and believe the company could spinoff BEF Foods at a substantial premium to its current value.

 

The food processing business is linked to the founding of the company and, to be clear, we fully appreciate the desire to maintain tradition within a business.  With that being said, we believe this connection is severely limiting the potential of the company.  Other than the historic connection between BEF Foods and Bob Evans Restaurants, there are very few, if any, synergies between the businesses.  We believe each business would benefit greatly from laser-focused, uncompromised operating strategies.  A separation would allow BOBE to focus on efficiently running its restaurants, while enabling BEF Foods to increase sales in the foodservice industry and further diversify its customer base.  As a separate entity, we believe BEF Foods would have an enormous runway for growth.

 

We maintain that such a transaction, in conjunction with significant SG&A cuts at BOBE, would result in substantial shareholder value creation for shareholders.

 

We strongly encourage you to review our Best Idea Presentation, in which we run through the bull case on BOBE.

 

BOBE: M&A Activity Heating Up in the Food Business - chart1

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


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